Standard Chartered took a $1 billion writedown on the value
of its business in the country in August, a cost that’s set to
end the London-based lender’s 11-year streak of record annual
profits. At Citigroup, Korea will hurt revenue in Asia through
2014, Chief Financial Officer John Gerspach has said.

Korean lenders have seen their return on equity, a measure
of profitability, shrink by more than half over the past decade
when Standard Chartered and Citigroup first pledged the largest-ever foreign investment in the country’s financial industry.
With the government stepping up efforts to curb household debt,
foreign banks have been left seeking ways to cut costs.

“Banks will have to accept the new normal of low growth,
low return on equity,” said Yoo Sang Ho, a Seoul-based banking
analyst at HI Investment & Securities Co. “They have to forget
what they saw in the mid-2000s.”

Standard Chartered, Citigroup and HSBC Holdings Plc (HSBA) first
started competing for Korean banks after the economy and banking
system rebounded from the 1990s Asian currency crisis that led
to an International Monetary Fund bailout. In 2004, New York-based Citigroup trumped Standard Chartered to buy Koram Bank for
about $2.7 billion. The following year, Standard Chartered beat
HSBC in acquiring Korea First Bank for $3.3 billion.

Debt Burdens

Over the past five years, Korean economic growth slowed to
2.9 percent from an average 5.8 percent in the nine years
through 2008, according to the IMF, as household debt swelled.
At the same time, commercial banks saw their ROE slump to about
7.4 percent last year from 20.3 percent in 2005, according to
data from the nation’s Financial Supervisory Service.

President Park Geun Hye, who took office in February, has
pledged to ease consumer debt burdens by restructuring loans for
low-income earners. The move follows measures already in place
since 2006 limiting the amount people can borrow depending on
their income and home values. In 2011, the financial regulator
asked banks to provide more fixed-rate loans to reduce risks
from increases in interest rates.

Bank lending rose 3.4 percent in 2012, the weakest since a
drop of 0.1 percent in 1998 amid the Asian currency crisis,
according to Bank of Korea data. Loan growth averaged 6.5
percent in the five years starting in 2008 after averaging about
17 percent in the previous nine years, the data show.

‘Hammered Profits’

“Rules that limit household lending must have hammered
profits at foreign banks who rely more on retail business than
their domestic peers,” said Kim Hye Mi, a researcher at Seoul-based Hana Institute of Finance.

Profit of all 18 lenders in the country including Standard
Chartered and Citigroup fell 42 percent to 4.8 trillion won ($4
billion) in the nine months through September as lending slumped
and margins on loans shrank to a four-year low, the FSS said.

The regulator said today it had ordered Citigroup and
Standard Chartered’s units to investigate allegations that staff
members or contract workers sold client information to private
lending agents. The FSS is waiting to hear from the two lenders
before deciding whether to conduct its own probe, Lee Sang Koo,
the director-general of the regulator’s bank supervision team,
said by phone today.

Profit Maximising

Government measures have hit foreign banks harder than
their Korean counterparts because they rely more on lending to
individuals. Loans to households accounted for about 71 percent
of lending at Standard Chartered Bank Korea Ltd. as of September
and 61 percent at Citibank Korea Inc., according to FSS data.
That’s compared with 55 percent and 45 percent, respectively at
Kookmin Bank, the nation’s biggest lender by assets, and Woori
Bank (053000), the second largest.

“Because of the government’s view, on the retail side you
have to conduct your business in a way that’s good for clients
which isn’t necessarily profit maximizing,” said Iain Clacher,
an associate professor in accounting and finance at Leeds
University Business School, who’s published research on the
economic development since the Korean war in the 1950s. “It’s
not a glamorous thing but it can be stable.”

Standard Chartered, which doesn’t provide quarterly
earnings figures, said in August its Korean consumer unit posted
a loss of $6 million after a $100 million profit a year ago.
Consumer banking revenue in the country may drop about 15
percent this year, it said on Dec. 4, without giving details.

Customer Networks

Net income at Citibank Korea fell 28 percent from a year
earlier to 145 billion won in the nine months ended September,
figures from the U.S. firm’s local unit show. Its ROE declined
to 3.3 percent in 2012 from 15.7 percent in 2005, the first full
year after it bought Koram Bank.

Standard Chartered and Citigroup have also struggled to
compete with domestic banks operating larger customer networks.

“With the limited contact points, it’ll be tough for them
to appeal to retail clients,” said Yoon Suk Heun, professor at
Soongsil University’s school of finance in Seoul.

Kookmin Bank operated 1,202 domestic branches as of
September, while Woori Bank had 993, according to regulatory
filings. Standard Chartered’s outlets totaled 347, down from 407
at the end of 2005. Citibank Korea operated 196, compared with
238 at the end of 2004, filings show.

Important Economy

Citigroup’s Gerspach said on Oct. 15 that the Korean market
will “continue to present a drag on year-over-year revenue
comparisons for Asia through at least next year.” Still, the
country “is one of Citi’s most important markets globally,”
said Mark Costiglio, a New York-based spokesman.

Standard Chartered remains committed to the Korean
business, with Chief Financial Officer Richard Meddings earlier
this month calling it an “important economy.” The bank sold
two non-core consumer finance businesses to help reduce its
exposure to higher-risk unsecured loans, according to the CFO.

Shaun Gamble, a spokesman for the lender, declined to
comment on any further plans involving Korea.

For its part, HSBC, Europe’s largest bank by assets, said
earlier this year it plans to wind down its retail banking and
wealth management business in Korea. The London-based lender
failed in at least three attempts to acquire local lenders since
it entered the Korean consumer market in 1998.

Korea Exit?

“The biggest problem for foreign banks was that they
didn’t expand in the high-growth years right after their
acquisitions, while domestic peers got bigger,” Heakyu Chang,
Seoul-based director of financial institutions at Fitch Ratings,
said in a telephone interview on Dec. 18. “They failed to
achieve a certain size” in order to compete.

Still, leaving the market may prove expensive as the
country’s tight labor laws make it difficult to cut staff. When
HSBC said in July that it would close 10 of its 11 offices to
focus on the global banking and markets business, it had to pay
some staff more than 50 months of severance pay, according to a
person familiar with the matter who asked not to be identified
because they weren’t authorized to speak publicly.

Standard Chartered’s efforts to base pay on performance to
become more competitive enmeshed it in the longest strike in
Korea’s banking history in 2011, when about 2,700 staff walked
out to protest potential job cuts.

Cost Controls

Soongsil University’s Yoon said banks may have to find
other ways to reduce costs, calling employment one of the
government’s “most important tasks.” There will be “tough
resistance” to any job cuts, he said.

“South Korea is too attractive a market to leave given its
economic size while it’s hard to meet expectations for earnings
as the banking industry is saturated,” said Kim Woo Jin, senior
research fellow at the Korea Institute of Finance in Seoul. “To
cope with falling profitability, they need to find ways to
control costs and to provide distinctive services.”